The phrase “passive income” is often thrown around by people wanting to make money by teaching you ways to earn it. Because the concept is so intriguing, there are a lot of misuses and misrepresentations of the term. After all, who doesn’t want to learn how to make thousands of dollars a month without doing anything to earn it?
The good news is that, with time, you can create a good amount of regularly occurring income without having to do a lot. This first installment in a two-part series is designed to familiarize you with the concept of passive income so you can begin exploring how it might fit into your financial situation and help you achieve your larger goals. So let’s get started!
What is it?
Passive income, by its most basic definition, is money coming in that doesn’t require you to devote much—or possibly any—ongoing time or effort.
One of the reasons there has been so much confusion over the term is that many people want to use the phrase passive income in a way that makes it synonymous with a side hustle or a second job. But because that type of work is, by definition, not passive, that usage isn’t appropriate. Work you do on the side can provide a big lift to your financial outlook, but it’s simply a different category altogether.
What are some examples?
Over the long haul, passive income sources have proven to be financially productive for many people, so getting to know the methods better is worth your effort.
Passive income could be from:
• Interest on a savings account or certificate of deposit (CD)
• Interest from a bond investment
• A money market fund
• Cash back on a debit or credit card
• Renting out a home, apartment, or room
• Real estate investment trusts (REITs)
• Renting out a vehicle or equipment
• Owning a stock that pays dividends
• An ownership stake in a business not requiring active involvement, such as a limited partnership
• Peer-to-peer (P2P) lending
• Crowdfunding apps
For perspective, keep in mind that some of these methods for building your nest egg didn’t exist a few years ago. With new technologies popping up all the time, there will inevitably be additional opportunities for passive income going forward. However, as these future techniques come online, it’s good to proceed cautiously.
Money-making avenues billed as “the next big thing” often lack the government oversight or regulatory framework to provide appropriate guarantees or protections for those investing in them. While getting in on the ground floor of a potentially lucrative new investment is tantalizing, it pays to do your homework and move forward cautiously.
Why is passive income important?
Any extra income you can generate without crimping your quality of life is always a nice bonus. After all, getting to where you want to be in life is typically hastened with an infusion of cash. Some people can even grow their passive income to the point they can switch to working part-time or even leave their day job entirely.
Many folks who have focused on growing their passive income report using the newfound freedom it provides to live in their dream location. This is just one example of the increased flexibility and opportunities larger amounts of passive income can create. There’s no guarantee this will be your outcome, but it does happen for some.
In the near term, having extra incoming cash flow from diversified sources could lessen your stress and help you withstand sudden increases in expenses or decreases in pay.
If you’re looking toward retirement, having income that isn’t as sensitive to fluctuations in the stock market could help take some of the anxiety out of your planning. You might even be able to shave a few years off your retirement age. Billionaire investor Warren Buffett Warren once said, “If you don’t find a way to make money while you sleep, you will work until you die.” While that may be extreme, the underlying sentiment contains a good amount of wisdom.
What else do I need to know?
Any of the above-listed sources of passive income requiring an investment of capital should only be entered into with an understanding of the potential risks accompanying your participation. Talking with a financial advisor can help you understand which investment types fit your situation and risk tolerance.
Similarly, it’s important to remember that sources of income typically come with tax ramifications. Discuss your potential liabilities with a tax professional to better understand how additional income could affect you when it’s time to give the IRS their due.
It’s essential to take to heart the idea that passive income streams generally take a while to grow into raging rivers of cash. They’re better suited for those with a get-rich-gradually mindset. You’ll be more likely to achieve long-term success if you’re not afraid to start small and stay patient.
As with any process for increasing your net worth, automation will work in your favor. To the greatest extent possible, try to make set-it-and-forget-it decisions for your passive income sources. Having automatic processes for reinvesting your gains back into your income streams will have you chugging along at a good clip.
Is your curiosity piqued? In part 2, we’ll go more in-depth about the sources of passive income listed above and discuss how to decide which might fit into your plan for financial success.
